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Complexity also adds to the danger that any one part of the hyper-financial system can bring down the whole. (...)

I can't count the times I've heard it said that we were no longer in danger of a 1929-type scenario because, precisely, today's financial system was more sophisticated -- risk was distributed, the multiplicity of instruments permitted hedging of a kind that guaranteed resistance to shocks and stability.

Now none other than the FT is breezily saying the opposite?

by afew (afew(a in a circle)eurotrib_dot_com) on Sat Jan 26th, 2008 at 09:15:36 AM EST
I've also seen much reference in the FT and elsewhere recently to a "Flight to Simplicity".

This October Discussion wound up with that as a "Key Lesson".

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Jan 26th, 2008 at 09:37:05 AM EST
[ Parent ]
More from Taleb on the Flight to Simplicity
The Simplicity Rule

A major rule should be taken into account: The market always tends to flow to simplicity. Complexity is generally costlier to both monitor and produce, and somehow in the long run, demand moves away from the complex in favour of the simple. New, elaborate contracts certainly attract people, but typically the novelty wanes. Operators will then try to satisfy their needs for protection by seeking the cheapest possible way.

Complex products cost more to replicate. An optimal operator becomes cost conscious and avoids enriching the financial institutions when he can satisfy his interests more economically. This becomes noticeable with the life or death of listed financial instruments. It is the recipe for the survival of exchange contracts. This rule will be discussed in the study of exotic options.

While he's writing about complex options contracts, the reasoning clearly applies to any financial instruments. Is it any wonder that the asset-backed commercial paper binge was going to end in indigestion as the more complex paper became illiquid?

We have met the enemy, and he is us — Pogo
by Migeru (migeru at eurotrib dot com) on Sat Jan 26th, 2008 at 11:39:03 AM EST
[ Parent ]
Exactly.

Very annoying, especially for those of us who looked at the complexity of risk and pronounced it dangerous and were shouted down by the likes of the FT.

by Metatone (metatone [a|t] gmail (dot) com) on Sat Jan 26th, 2008 at 09:43:07 AM EST
[ Parent ]

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